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Let's Look At The Economy... image

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With the February jobs data on tap this morning, it is a safe bet that the Big Kahuna of economic data will be the focal point of the session (or at least the first 5 minutes, anyway). However, it is important to recognize that the state of both the U.S. and global economies has been at the forefront of traders' minds during the vast majority of the current bear market period. So, this morning I'd like to put some recent economic data under a microscope and see if there is a message that can be gleaned.

On Thursday, there was a plethora of economic reports to review including Markit's Services PMI, the ISM Non-Manufacturing Index, Challenger's Planned Job Cuts, Weekly Jobless Claims, Vehicle Sales, Bloomberg Consumer Comfort, Factory Orders and Q4 Nonfarm Productivity. And yes, I will forgive you if you decide to hit delete at the end of this sentence as poring over economic data is not exactly exciting stuff for most folks!

But here's the deal, I've already done the heavy lifting and have sifted through the mounds of paper for you. As such, the following are what I perceive to be the "nuggets" from the days data.

Just the Facts Ma'am

Let's start with the ISM Non-Manufacturing Index (NMI). This index is designed to tell us the state of the services sector. Readings above 50 indicate that the services sector is expanding, while readings below 50 indicate contraction.

Why do you care about this report? Remember, that the consumer (aka the services sector) accounts for about 70% of U.S. GDP. So, as consumer activity goes, so goes the economy.

The good news is the NMI came in above the consensus estimate. And February's reading of 53.4 was comfortably above 50, which suggests continued growth. In addition, comments from the survey suggested that most remain upbeat about the future as the "slight optimism" box received the most check marks.

The bad news is that the NMI fell 0.1 from January and now sits at the lowest absolute reading in two years. Next, three of the four component indices declined, including employment, which slipped below the expansion/contraction line to a reading of 49.7. In fact, this was the first time that the employment component shrank in the last two years.

When you combine the current ISM NMI reading with the fact that the ISM Manufacturing Index showed signs of stabilizing this month, the key takeaway is that the economy continues to expand and the risk of recession is limited here in the good 'ol USofA.

I know what you're thinking.... Didn't Markit's Services PMI stink up the joint yesterday? Yes, this is indeed true. The separate measure of service sector business activity did disappoint in February with a reading of 49.7 - the first contraction reading since October 2013. And the 12-Month Outlook reading fell to the lowest level since August 2010. Yikes!

However, before you start looking for which 3X inverse ETF to bomb into here, let's review the differences in the two data sets. (And yes, I promise this will be worth your time!)

You see, the construction of the Markit Business Activity Index differs greatly from the ISM NMI. While the ISM takes the equal-weighted average of four components (business activity, new orders, employment and deliveries), the Markit report looks ONLY at business activity.

But wait, there's more! Markit's methodology also is prone to seasonal impacts... Can you say, "Blame it on the weather?"

Sure enough, the Markit report noted that the heavy snowstorms in the Northeast were one of the factors that weighed on the index last month. And as such, the bulls will argue that the index dropping below the Mason Dixon line (i.e. below 50 and into the contraction zone) was an aberration that could quickly be reversed next month. (See, I told you there would be a payoff! Data can be fun, right?)

All About Jobs...

Next, let's look at the Challenger data, which is a monthly report on the number of jobs that corporate America plans to cut. Yesterday, Challenger reported that planned job cuts fell 18% in February to 61,559. However, for the first two months of the year, planned layoffs come in at the highest level since 2009 and the 12-month average was the highest since June 2012. But, the report also indicated that, for now, job cuts are limited primarily to certain sectors and regions. (Can you say, oil?)

And Cars...

Another bright spot in the economic data can be found in the report of Light Vehicle Sales. The bad news is sales of "light vehicles" edged down 0.1% last month. The good news is that sales remain in line with the 12-month average. And given that the 12-month average is currently at its highest level since November 2000, the trend is looking pretty good.

And Worker Productivity/Income...

Finally, there is the report on Nonfarm Productivity - i.e. worker output. The final reading for Q4 Productivity was revised upward from -3.0% to -2.2%, which is a good thing on a relative basis. However, the -2.2% reading is the largest drop seen in productivity in nearly two years. And on a year-over-year basis, productivity was up just 0.5%, which is the slowest since... wait for it... 1983. Ughh.

The good news is that workers are earning more money. Real hourly comp was revised to 0.9% for the quarter, which was the sixth consecutive quarterly gain. On an annual basis, earnings were up 2.1%, which is significantly better than the average of +0.6% seen during the current economic expansion. In short, this data suggests the consumer's purchasing power is improving.

The Takeaways...

Let's sum up. First, we need to recognize that manufacturing is in recession. The good news is the services sector, which dominates US GDP, continues to grow - just at a slightly slower rate. The consumer seems to be happy and is buying cars (likely in response to their savings at the gas pump). And the employment data continues to be solid - but today's jobs report will help us determine if the job market is showing any signs of slowing.

So, the first point I'd like to make is that anyone suggesting that the US is heading for recession isn't looking at the data very hard. Sure, things are slowing. But at this point in time, the data suggests that growth is not slowing enough for a recession to be a serious consideration.

My bottom line take, which of course, is completely subjective, is that (a) global weakness may be creeping in and (b) the oil bust may be starting to show up in some of the data. But for now, the risk of recession in the US, while higher than it was, is not high enough to warrant concern at this time.

However, the same cannot be said for the global economy as risks continue to rise and economies continue to weaken. As such, it will be important to continue to review the economic data from around the world as it comes in. And the good news is that we'll be monitoring it for you and will report any important findings when they occur.

Turning to This Morning

Sticking with the economic theme for today's report, the big news this morning is the stronger than expected jobs report. U.S. Nonfarm payrolls for February had been expected to come in at 195K, but were reported at 242K. In addition, revisions to both the January and December totals added 30,000 jobs. This means the average job gains for the last 3 months now stands at 228K. The private sector added 230K jobs. The official unemployment rate held steady at 4.9% while the "real" unemployment rate, as measured by the U6 is now 9.7%, which is the lowest since May 2008. And finally, average hourly earnings fell -0.1. All in all, this was a strong report. As far as the market reaction goes, stock futures in the U.S. have improved smartly on the news and now point to rally at the open.

Today's Pre-Game Indicators

Here are the Pre-Market indicators we review each morning before the opening bell...

Major Foreign Markets:
    Japan: +0.32%
    Hong Kong: +1.18%
    Shanghai: +0.50%
    London: +0.83%
    Germany: +0.98%
    France: +0.86%
    Italy: -0.52%
    Spain: +0.63%

Crude Oil Futures: +$0.29 to $34.86

Gold: +$6.00 at $1264.20

Dollar: lower against the yen and euro, higher vs. pound

10-Year Bond Yield: Currently trading at 1.830%

Stock Indices in U.S. (relative to fair value):
    S&P 500: +9.45
    Dow Jones Industrial Average: +80
    NASDAQ Composite: +26.04

Thought For The Day:

The great question is not whether you have failed, but whether you are content with failure. -Chinese Proverb

Here's wishing you green screens and all the best for a great day,

David D. Moenning
Founder and Chief Investment Strategist
Heritage Capital Research

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Looking for More on the State of the Markets?

Current Market Drivers

We strive to identify the driving forces behind the market action on a daily basis. The thinking is that if we can both identify and understand why stocks are doing what they are doing on a short-term basis; we are not likely to be surprised/blind-sided by a big move. Listed below are what we believe to be the driving forces of the current market (Listed in order of importance).

      1. The State of the Oil Crisis
      2. The State of Global Central Bank Policy
      3. The State of the Stock Market Valuations
      4. The State of Global Growth

The State of the Trend

We believe it is important to analyze the market using multiple time-frames. We define short-term as 3 days to 3 weeks, intermediate-term as 3 weeks to 6 months, and long-term as 6 months or more. Below are our current ratings of the three primary trends:

Short-Term Trend (1 - 3 Weeks): Positive
(Chart below is S&P 500 daily over past 1 month)

Intermediate-Term Trend (1 - 6 Months): Moderately Negative
(Chart below is S&P 500 daily over past 6 months)

Long-Term Trend (6 - 18 Months): Moderately Negative
(Chart below is S&P 500 daily over past 2 years)

Key Technical Areas:

Traders as well as computerized algorithms are generally keenly aware of the important technical levels on the charts from a short-term basis. Below are the levels we deem important to watch today:

  • Key Near-Term Support Zone(s) for S&P 500: 1950(ish)
  • Key Near-Term Resistance Zone(s): 2010

The State of the Tape

Momentum indicators are designed to tell us about the technical health of a trend - I.E. if there is any "oomph" behind the move. Below are a handful of our favorite indicators relating to the market's "mo"...

  • Trend and Breadth Confirmation Indicator (Short-Term): Positive
  • Price Thrust Indicator: Positive
  • Volume Thrust Indicator(NASDAQ): Positive
  • Breadth Thrust Indicator (NASDAQ): Positive
  • Short-Term Volume Relationship: Positive
  • Technical Health of 100+ Industry Groups: Neutal

The Early Warning Indicators

Markets travel in cycles. Thus we must constantly be on the lookout for changes in the direction of the trend. Looking at market sentiment and the overbought/sold conditions can provide "early warning signs" that a trend change may be near.

  • S&P 500 Overbought/Oversold Conditions:
          - Short-Term: Overbought
          - Intermediate-Term: Neutral
  • Market Sentiment: Our primary sentiment model is Neutral

The State of the Market Environment

One of the keys to long-term success in the stock market is stay in tune with the market's "big picture" environment in terms of risk versus reward.

  • Weekly Market Environment Model Reading: Neutral

Indicator Explanations

Trend and Breadth Confirmation Indicator (Short-Term) Explained: History shows the most reliable market moves tend to occur when the breadth indices are in gear with the major market averages. When the breadth measures diverge, investors should take note that a trend reversal may be at hand. This indicator incorporates an All-Cap Dollar Weighted Equity Series and A/D Line. From 1998, when the A/D line is above its 5-day smoothing and the All-Cap Equal Weighted Equity Series is above its 25-day smoothing, the equity index has gained at a rate of +32.5% per year. When one of the indicators is above its smoothing, the equity index has gained at a rate of +13.3% per year. And when both are below, the equity index has lost +23.6% per year.

Price Thrust Indicator Explained: This indicator measures the 3-day rate of change of the Value Line Composite relative to the standard deviation of the 30-day average. When the Value Line's 3-day rate of change have moved above 0.5 standard deviation of the 30-day average ROC, a "thrust" occurs and since 2000, the Value Line Composite has gained ground at a rate of +20.6% per year. When the indicator is below 0.5 standard deviation of the 30-day, the Value Line has lost ground at a rate of -10.0% per year. And when neutral, the Value Line has gained at a rate of +5.9% per year.

Volume Thrust Indicator Explained: This indicator uses NASDAQ volume data to indicate bullish and bearish conditions for the NASDAQ Composite Index. The indicator plots the ratio of the 10-day total of NASDAQ daily advancing volume (i.e., the total volume traded in stocks which rose in price each day) to the 10-day total of daily declining volume (volume traded in stocks which fell each day). This ratio indicates when advancing stocks are attracting the majority of the volume (readings above 1.0) and when declining stocks are seeing the heaviest trading (readings below 1.0). This indicator thus supports the case that a rising market supported by heavier volume in the advancing issues tends to be the most bullish condition, while a declining market with downside volume dominating confirms bearish conditions. When in a positive mode, the NASDAQ Composite has gained at a rate of +38.3% per year, When neutral, the NASDAQ has gained at a rate of +13.3% per year. And when negative, the NASDAQ has lost at a rate of -8.5% per year.

Breadth Thrust Indicator Explained: This indicator uses the number of NASDAQ-listed stocks advancing and declining to indicate bullish or bearish breadth conditions for the NASDAQ Composite. The indicator plots the ratio of the 10-day total of the number of stocks rising on the NASDAQ each day to the 10-day total of the number of stocks declining each day. Using 10-day totals smooths the random daily fluctuations and gives indications on an intermediate-term basis. As expected, the NASDAQ Composite performs much better when the 10-day A/D ratio is high (strong breadth) and worse when the indicator is in its lower mode (weak breadth). The most bullish conditions for the NASDAQ when the 10-day A/D indicator is not only high, but has recently posted an extreme high reading and thus indicated a thrust of upside momentum. Bearish conditions are confirmed when the indicator is low and has recently signaled a downside breadth thrust. In positive mode, the NASDAQ has gained at a rate of +22.1% per year since 1981. In a neutral mode, the NASDAQ has gained at a rate of +14.5% per year. And when in a negative mode, the NASDAQ has lost at a rate of -6.4% per year.

Bull/Bear Volume Relationship Explained: This indicator plots both "supply" and "demand" volume lines. When the Demand Volume line is above the Supply Volume line, the indicator is bullish. From 1981, the stock market has gained at an average annual rate of +11.7% per year when in a bullish mode. When the Demand Volume line is below the Supply Volume line, the indicator is bearish. When the indicator has been bearish, the market has lost ground at a rate of -6.1% per year.

Technical Health of 100 Industry Groups Explained: Designed to provide a reading on the technical health of the overall market, this indicator takes the technical temperature of more than 100 industry sectors each week. Looking back to early 1980, when the model is rated as "positive," the S&P has averaged returns in excess of 23% per year. When the model carries a "neutral" reading, the S&P has returned over 11% per year. But when the model is rated "negative," stocks fall by more than -13% a year on average.

Weekly State of the Market Model Reading Explained:Different market environments require different investing strategies. To help us identify the current environment, we look to our longer-term State of the Market Model. This model is designed to tell us when risk factors are high, low, or uncertain. In short, this longer-term oriented, weekly model tells us whether the odds favor the bulls, bears, or neither team.


Disclosures

The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning's opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report is for informational purposes only. No part of the material presented in this report is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed constitutes a solicitation to purchase or sell securities or any investment program.

Any investment decisions must in all cases be made by the reader or by his or her investment adviser. Do NOT ever purchase any security without doing sufficient research. There is no guarantee that the investment objectives outlined will actually come to pass. All opinions expressed herein are subject to change without notice. Neither the editor, employees, nor any of their affiliates shall have any liability for any loss sustained by anyone who has relied on the information provided.

The analysis provided is based on both technical and fundamental research and is provided "as is" without warranty of any kind, either expressed or implied. Although the information contained is derived from sources which are believed to be reliable, they cannot be guaranteed.

David D. Moenning is an investment adviser representative of Sowell Management Services, a registered investment advisor. For a complete description of investment risks, fees and services, review the firm brochure (ADV Part 2) which is available by contacting Sowell. Sowell is not registered as a broker-dealer.

Employees and affiliates of Sowell may at times have positions in the securities referred to and may make purchases or sales of these securities while publications are in circulation. Positions may change at any time.

Investments in equities carry an inherent element of risk including the potential for significant loss of principal. Past performance is not an indication of future results.

Advisory services are offered through Sowell Management Services.